In-the-money option In a call option, when the strike price of the contract is less than the prevailing spot market price of the underlying stock/index, it's an in-the-money option. It's the opposite in a put option.
At-the-money options When an option contract is struck at a strike price which is equal to the prevailing market price of the underlying stock/index, it is referred to as an at-the-money option.
Out-of-money options For call options, when the strike price of the contract is higher than the prevailing spot market price, it is a case of an out-of-money option. For put options, the opposite is true.
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If you are bullish on a certain stock and feel that it will rise, but not above a certain level, you can use a bull spread strategy. It’s a simple strategy that helps you capitalise on the upside, but keeps the premium costs down. Normally, if you are bullish on a stock, you would just buy its call option for a certain premium. But a bull spread goes a little further as one also sells a call of a higher strike price simultaneously.
What does it cost?
When you buy a call option, you incur a premium. But as you also sell a higher priced call, you earn a small premium. Thus, the premium cost on buying the lower strike price call option is partially offset by the premium you earn on writing the higher strike price call option.
When to use it?
You could opt for this strategy to cut down the cost of buying the call option by earning some premium by writing the higher priced call option.
What are the rewards?
The bull spread call is most profitable when the spot market price closes above the higher strike price at the expiry date and both options expire in-the-money. This would be the case no matter how high the spot market price closes above the higher strike price on the expiry date. The return will be fixed. The return will be equal to the higher strike price, less the lower strike price, less the net premium outgo.
If the spot market price settles down between the strike prices on the expiry date, the long call will be in-the-money and worth its intrinsic value. The short call will go unexecuted. The return will be equal to the spot market price at expiry, less the long call strike price, less net premium outgo. The maximum loss for this spread will occur when the spot market price settles below the lower strike price on the expiry date. This would lead to both options expiring out-of-the-money and the loss will amount to the net premium outgo.
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